CPI comes in lower but IIP actually flatters on the upside…

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It was a day of positive macro flows for the Indian economy on the inflation and the industrial growth front. Inflation came in slightly lower helped by lower food inflation. Of course, non-food inflation continues to be on the higher side but that is more due to the impact of higher oil prices post the OPEC deal. But IIP at 5.7% was the real big surprise. In fact, IIP has come in much higher than the normal trend. The month of November was expected to be subdued on the industrial growth front due to the impact of demonetization. However, the weak footfalls and the tepid demand faced by the consumer-facing sectors do not seem to have translated into lower growth. That is a paradox that needs to be delved into a little deeper.…

Inflation comes in lower than anticipated…

As the above chart depicts, the food inflation has fallen below the overall CPI inflation and has sustained below for the last 4 months. This has largely been driven by a good monsoon after 2 successive years of drought as well as a 9% improvement in Kharif output. That means that the CPI inflation has sustained below the RBI comfort level of 5% for over 5 months now despite the risk of the base effect. The only factor to be observed is the impact of the demonetization on the Rabi sowing season and the resultant impact on food inflation, although that is not expected to be anything material.

Within the overall gamut of CPI inflation, vegetables with -14.59% inflation and pulses with -1.57% inflation were responsible for the downward pressure on food inflation. Also, the gap between rural inflation and urban inflation has compressed substantially over the last one year. However, as the MPC minutes brought out, the multiplier effect of oil cannot be overlooked and that means upside risks to inflation still remain.

Does it indicate a further scope for rate cuts by the RBI?

While the consistent fall in overall food inflation and food inflation surely makes a strong case for rate cuts by the RBI, we believe that the central bank may adopt a more cautious and calibrated approach towards rate cuts. There are 3 broad reasons for the same. Firstly, the previous MPC minutes has underscored the fact that non-food inflation continues to be sticky. Combined with strong oil prices, it opens up upside risks to retail inflation. The RBI will be watchful of this parameter. Secondly, the demonetization drive has led to a substantial increase in deposits with the banking system. That has led banks to cut their MCLR by 60-90 basis points. As a result, the overall transmission of rate cuts to the end customer is now nearly 100% if rate cuts since January 2015 are considered. The immediate priority of the RBI will be to evaluate the impact of this lower MCLR on credit off-take before taking a view on rate cuts. Lastly, the spectre of a hawkish Fed policy still continues. While Trump may not have given too many hints in his first press conference, the RBI would want to avoid a situation where the yield gap between the US and Indian generic falls to an unattractive level. These 3 factors may force the RBI to seriously calibrate any rate cut decision, at least in the Feb policy.

But, IIP growth is what actually flattered on the upside…

The sharp improvement in IIP growth was driven by manufacturing growth. Historically, it is the manufacturing growth and the IIP that have tended to have a higher correlation due to the high proportion of manufacturing in the IIP basket. For the month of November, all the 3 components of IIP have done extremely well. While mining was up by 3.9% and manufacturing was up by 5.5%, it was electricity that surprised on the upside with a growth of 8.9%. The sharp spurt in manufacturing is actually a paradoxical surprise considering that the months of November and December were actually hit by the cash crunch caused by the demonetization drive. But paradoxically, 16 out of the 22 industries evaluated under the head of manufacturing have actually shown a positive growth during the month of November. Electricity, passenger cars, rubber cables and tractors contributed majorly to the higher IIP number in November.

What are the key takeaways from the IIP numbers?

It may be too early to call a revival but there is good news on the user based classification front. Capital goods segment has registered a 15% growth. This may be partly attributed to a lower base, but despite that the growth is a good sign. Of course, this growth figure will have to be sustained and also ratified by a pick-up in credit off-take and a gradual improvement in PMI figures on a monthly basis. If the PMI-manufacturing and the PMI-Services bottom out and get back above the 50-mark, then there could be better hope of the IIP sustaining at an elevated level. The good news for the time being is that the demonetisation does not seem to have impacted industrial growth, as was popularly expected by the markets. That could be the key positive take-away from the IIP numbers.

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